Warranties and indemnities are often provided in the purchase agreement by the selling party for the benefit of the buying party in the context of a (share) transaction. What are warranties and indemnities and what is the difference between these two Dutch contractual provisions?
Warranties
Within Dutch law, the term 'warranty' does not have a well-defined legal concept. A warranty is a contractual provision that must be interpreted in order to determine its contents and legal consequences, whereby it comes down to the Haviltex standard ('the meaning that the parties may reasonably attach to the provision in the given circumstances and what they may reasonably expect from each other in this respect'). If a warranty has been carefully drafted in a purchase agreement, heavy weight is also attached to its (literal) wording.
A purchaser will often demand as many and as extensive warranties as possible from the seller. The seller, on the other hand, will want to limit the number of warranties and their effect as much as possible. There is therefore an area of tension. Who bears what risk is always a matter of risk allocation between the seller and purchaser.
Often a warranty will be a statement about the existence or absence of a certain fact. A selling party is expected to at least issue warranties with respect to, among other things, its own authority, the target and the shares (the so-called 'title warranties'). It is customary for such warranties of title to be also included in the notarial deed of transfer. In addition, one can think of issuing a balance sheet warranty, business warranties (including with respect to (material) contracts and disputes) and a general information warranty (for example, the warranty that the seller has shared all relevant information with the purchaser and that all shared information is correct, complete and not misleading). Which warranties are relevant and ultimately included will depend on the specific business and the negotiation process between the seller and the purchaser. However, it is common that the number of warranties are extensive, assuming that the seller is responsible for the target and its business until the date of closing of the transaction.
Indemnities
Indemnifications provide a risk allocation with regard to facts and circumstances that have already become apparent. A breach of contract is not an necessity. In principle, this means that it is clear in advance which of the parties will bear the consequences of a particular event. For example an indemnity could be provided for specific (financial) risks that have emerged during the (legal) due diligence. For tax, it is nowadays market practice to include a general tax indemnity, so even if no facts and circumstances give rise to asking for such tax indemnity.
For indemnities, it is also true that such contractual arrangements need to be interpreted in order to determine their content and legal effect, where the common standard (verkeersopvattingen) may be relevant. The consequence of an indemnity, is that the seller will have to bear all costs, damages et cetera relating to the event covered by such indemnity. For example, it can be agreed that an obligation of the target to pay future clean-up costs (in the event of soil pollution which emerged during the due diligence) is passed on to the seller and thus the risk is placed on the seller instead of (indirectly) on the purchaser.
Differences between warranties and indemnities
In general, the following differences can among others be distinguished between warranties and indemnities:
- an indemnity, unlike a warranty and apart from a tax indemnity, usually relates to a specific event whereby -at the time of entering into the purchase agreement- it is foreseeable that it will have adverse financial consequences for the target;
- unlike a warranty, the usual limitations (including threshold amounts, caps, specific terms etc.) do usually not apply, or apply to a lesser extent, to an indemnity;
- knowledge of a purchaser (e.g. by conducting due diligence), unlike in the case of an indemnity, detracts from the scope of a warranty, meaning that a purchaser cannot invoke a warranty in the event information in respect of such warranty is disclosed during the due diligence.
The difference between a warranty and an indemnity under Dutch law is not entirely clear, since these are not well-defined concepts and must be interpreted by way of explanation. Both are clauses whose purpose is to make the seller bear a financial risk. It is therefore also important to formulate the provisions on warranties and indemnities carefully, to prevent a party from being faced with financial setbacks afterwards. In this context, we will be happy to provide you with legal advice.
